The Central Bank Balance Sheet and the Money Supply Process Chapter 11 The Central Bank Balance Sheet and the Money Supply Process

CONTENS 11.1 The Central Bank’s Balance Sheet 11.2 Changing Central Bank Balance Sheet 11.3 The Deposit Expansion Multiplier 11.4 Monetary Base and the Money Supply 11.5 Arithmetic of Money Multiplier 11.6 Limits on Central Bank’s Control of Money Supply

10.1 The Central Bank’s Balance Sheet Web Link

The Central Bank’s Balance Sheet 1. Assets Securities Fed holds only U.S. Treasury securities controlled through purchases and sales known as “open market operations.” Foreign Exchange Reserves bonds issued by foreign governments Loans Discount Loans Float

The Central Bank’s Balance Sheet 2. Liabilities Currency Government Accounts Reserves Commercial Bank’s Checking Accounts

The Central Bank’s Balance Sheet 3. Monetary Base (or High-Powered Money) Currency held by the public + reserves in the banking system Bank Reserves = Vault Cash + Deposits at the Fed. The central bank can control the size of the monetary base.

11.3 Changing Size and Composition of the Balance Sheet 1. Open Market Operations The Federal Reserve buys or sells securities in financial markets.

Changing Size and Composition of the Balance Sheet Open Market Operations

Changing Size and Composition of the Balance Sheet 2. Foreign Exchange Intervention

Changing Size and Composition of the Balance Sheet Foreign Exchange Intervention

Changing Size and Composition of the Balance Sheet 3. Discount Loans

Changing Size and Composition of the Balance Sheet Discount Loans Discount Loans

Changing Size and Composition of the Balance Sheet 4. Cash Withdraws Cash Withdraws

Changing Size and Composition of the Balance Sheet Cash Withdraws

Changing Size and Composition of the Balance Sheet Cash Withdraws

Deposit Expansion Multiplier Deposit Creation in a Single Bank

11.3 Deposit Expansion Multiplier 1.Deposit Creation in a Single Bank (1) Types of Reserves Actual Reserves (R) Required Reserves (RR=rDD) Excess Reserves (ER)

Deposit Expansion Multiplier Deposit Creation in a Single Bank

Deposit Expansion Multiplier Deposit Creation in a Single Bank

Deposit Expansion Multiplier Deposit creation in a single bank (2) As a result of a $100,000 purchases of securities from bank by the Fed M1 increases $100,000. Checkable deposits increase $100,000.

Deposit Expansion Multiplier 2. Deposit creation by a system of banks (1) Assume Bank hold no excess reserves. The reserve requirement ratio is 10% Currency holding doe not change when deposits and loans change. When a borrower writes a check, none of the recipients of the funds deposit them back in the bank that initially made the loan.

Deposit Expansion Multiplier Deposit creation by a system of banks

Deposit Expansion Multiplier Deposit creation by a system of banks

Deposit Expansion Multiplier Deposit creation by a system of banks

Deposit Expansion Multiplier Figure 17.17: Multiple Deposit Creation $100,000 $100,000 Reserves Reserves Federal Reserve First Bank $100,000 Office Builders Inc. Federal Loan Reserve $100,000 $100,000 Securities Securities $100,000 Payment Third Bank $90,000 $90,000 Second Bank $100,000 $100,000 American Steel Co. Deposit Deposit Loan Loan Retains $9,000 in Retains $9,000 in Reserves Reserves Retains $10,000 in Reserves Retains $10,000 in Reserves $81,000 $81,000 $72,900 $72,900 $65,610 $65,610 Loan Loan Fourth Bank Fifth Bank Loan Loan Loan Loan and on and on and on. and on. Retains $8,100 in Reserves Retains $7,290 in Reserves Assuming a 10 percent reserve requirement, banks hold Assuming a 10 percent reserve requirement, banks hold no excess reserves, and there are no changes its currency holdi no excess reserves, and there are no changes its currency holdi ngs. ngs.

Deposit Expansion Multiplier

Deposit Expansion Multiplier 3. Deposit creation by a system of banks RR = rDD or ΔRR = rDΔD So for every dollar increase in reserves, deposits increase by

Deposit Expansion Multiplier Deposit creation by a system of banks RD=10% (0.10), and ΔRR=$100,000 ΔD= ΔD= $1,000,000

Deposit Expansion Multiplier 4. Deposit Expansion with Excess Reserves and Cash Withdraws. (1) Assume: 5% withdraw of cash. Excess reserves of 5% of deposits

Deposit Expansion Multiplier Deposit Expansion with Excess Reserves and Cash Withdraws.

Deposit Expansion Multiplier (2) Deposit Expansion with Excess Reserves and Cash Withdraws. The desire of banks to hold excess reserves and the desire of account holders to withdraw cash both reduce the impact of a given change in reserves on the total deposits in the system. The more excess reserves banks desire to hold, and the more cash that is withdrawn, the smaller the impact.

Deposit Expansion Multiplier (3) Deposit Expansion with Excess Reserves and Cash Withdraws. Ratios Excess Reserve Ratio {ER/D} Currency Ratio {C/D}

11.5 Arithmetic of Money Multiplier Deposit Expansion with Excess Reserves and Cash Withdraws.

Deposit Expansion Multiplier 5. The Quantity of Money (M) Depends on: The Monetary base (MB), Controlled by the Fed. Reserve Requirements Bank’s desired to hold excess reserves. The public’s demand for currency.

Deposit Expansion Multiplier

Deposit Expansion Multiplier

Deposit Expansion Multiplier

Chapter 11 End of Chapter